AEB 3103 Principles of Food and Resource Economics

Module 6: The Economics of Taxation

In this world nothing can be said to be certain, except death and taxes - Benjamin Franklin

What is the first word you think about when you think about tax?

Type of taxes

And here’s a couple of statement about taxes. Are they correct?

A simple model on tax

Say the government imposes a tax of $40 on each night of hotel room stay.

If demand of some good is more elastic than supply and a tax is imposed on the consumption of the good, who will bear more of the burden of the tax?

  1. producers, because consumers have a greater ability to change their behavior in response to the tax
  2. both parties will share the burden equally
  3. consumers, because they pay the tax out of pocket
  4. the government, because the tax will cause less of the good to be produced and consumed

In-class exercise

The demand curve for apple is P = 10 - 2Q. The supply curve for apple is P = 0.5Q. The government decided to impose a 30% tax on all apples sold in the supermarket, levied on the consumers. Please calculate:

  1. The market equilibrium without the apple tax
  2. The market equilibrium with the apple tax
  3. Government’s tax revenue
  4. The share of taxes paid by consumers vs. producers
  5. The amount of deadweight loss as a result of the tax

Exercise tax creates distortion

If we have to tax consumption, which of the followings should we tax in order to minimize distortion?

Two remaining questions

  1. Do we actually want lower or higher tax rates?
  1. Given a fixed tax revenue target, which taxes should be levied?

1. Lower or higher taxes

Two very different paradigms:

Public services in Denmark

Arguments for/against higher taxes

  1. Tax evasion: people find ways to evade paying taxes
  1. Tax avoidance: selective taxation creates distortion
  2. Supply-side economics: cutting taxes stimulates the economy

What should be taxed if we have to tax?

In some instances, we may want tax to achieve specific goals - in those cases, tax is designed to be non-neutral: * Encourage home ownership * Encourage health insurance adoption * Discourage carbon emission - Pigovian tax: correcting externality-generated distortion * Discourage cigarette consumption

What does the mortgage deduction program incentivize?

A note on externality and Pigovian tax

Deadweight loss with externality

Pigovian tax corrects externality